Thursday, 5 December 2013

British banks gone AWOL

The banking sector is
in dereliction of its traditional duties in the economy and quick fixes will
not be enough to make amends

After nearly collapsing and bringing the economy down with
them, UK banks are further adding to their bad name by holding back the
economic recovery. Banks are either too
weak or too caught up in making easy money to fulfil their traditional role in
the economy. The situation is made worse
because monetary policy works through the financial sector and banks are
crucial links through which money is fed into the actual economy. Instead,bank lending to UK businesses has been falling, thereby
dampening the impact of lower interest rates and pushing the Bank of England to
pump more and more money into the economy (which is not healthy). Why have banks seemingly abandoned their
posts?

Banks have traditionally acted as intermediaries between
those with money to spare and those in need of financing. There is a surplus of funds at the moment due
to quantitative easing by the central banks which is aimed at getting more
households and companies to borrow. But
this money is not getting to businesses - partly because the weak economy has
hit demand for loans but also because of the reluctance of banks to lend. A large amount of debt, which could go bad due
to the weak economy, is making banks cautious while new banking regulations are
restricting banks’ capacity to take on fresh loans. Small businesses have been hit hardest as
there are few other options for getting cash.
As a result, there has been a large knock-on effect on the economy as
small businesses are a significant source of jobs and innovation.

Other parts of the finance sector have failed to pick up the
slack. Investment banks (which are
different to retail banks who carry out the functions above) have long had only
weak links with the actual economy and continue to generate profits through
their ability to make money from money while also attracting some of the best
and brightest who could offer more in other sectors (see previous blog). Firms such as Wonga, which offer lending services now shunned by
retail banks, are being hounded for their trouble. The only bright spot has been mortgage
lending but that has been targeted by government initiatives along with
monetary policy to the extent that the Bank of England has had to apply the brakes due to
concerns about a housing bubble.

The failure of banking to facilitate the circulation of
funds around the economy has resulted in surplus cash flowing into financial
assets such as property or the stock market rather than being put to productive
use in the actual economy. The Bank of
England has tried a scheme of providing banks with funds for lending but more
needs to be done to clean up banks and change their behaviour. One of the reasons why Japan took so long to
recover from a financial crisis more than two decades ago was that it allowed problems
in its banking sector to stagnate. Let’s
hope that it doesn’t take that long to learn the same lesson.